What is Momentum telling us?

The observations I have shared over the past number of months in regard to the market, which have pointed to an over-valued condition in a supportive technical environment, are unchanged this week. So, rather then write (while I am on vacation) on the subjects I typically cover each week, I thought it appropriate to share my views on momentum and where the market is presently. The headline observation is that momentum is close to or has peaked. Using history as a guide, momentum indicators say it is time to limit exposure from long positions.


Consider the following:

1) New York Stock Exchange Volume: One of the calculations I perform each week is to compute the five day average of volume on the NYSE. I then compare the current five day period to the prior five day period and take the difference. On a running basis this difference is summed to develop a picture of net volume change over time. This is contrasted with the net point change over time in the stock indexes. The momentum change here is significant as since February 12, 2016 the DJIA has risen by roughly 2,500 points, but the cumulative volume change has lost momentum going from a net positive volume change of 850 million shares to only 115 million positive shares today. The percentage of day-to-day advancing volume and issues over declining volume and issues are supportive of an advancing market, but the decline in overall volume participating in the market points to a market that is losing steam, losing momentum. The decline in net cumulative volume noted above may be criticized in an off-handed manner as not addressing seasonality, but the truth is that last year at this time we were net positive over 900 million shares, so the summer is not the driving force here. It is simply a decline in overall demand that is occurring under the surface.

2) Relative Strength momentum as pictured through variance from the mean (Standard Deviation) is in the tail portion of the curve for both RS moves higher and for RS moves lower. The measures here compute the cumulative DJIA point moves higher for each week in a twelve week period, and separately computes the cumulative DJIA point moves lower for each week in the same twelve week period. This data has been tracked going back to the year 2010. The up move benchmark is 231 points whereas the current SD up measure is at 316 points, indicating we are in the upward end of the tail that will bring about a reversal or a decline to enable a reversion to the mean. For the RS down measure the benchmark is 345 points whereas the current SD down measure is at 166 points, indicating this too is in the tail, but in the low tail end that will bring about a reversal or a surge in downward points to enable a reversion to the mean here.

3) Lastly, the data above is put in context by using an oscillator of Relative Strength. This view is to determine inflection points and to give some sense of timing of when a reversal move may take place. It does not measure the size of the move, only the potential timing and the direction of the move. Over time the RS down oscillator has indicated a turning point lower for the market when the Oscillator reaches a negative 150 point reading. We are presently at negative 145 points. The range of the oscillator over the past ten years for downward Relative Strength is positive 5 and negative 150. At a negative 150, the market has consistently over time reversed its move higher and headed lower within the next one to four weeks. For the upward RS Oscillator, the peak point is positive 50 points, which when reached typically signals a market top is near. The RS Up oscillator hit positive 50 points two weeks ago.

I share the above with you to simply change the focus. It is clear to me that we are fundamentally over-valued to the point of extremes that are setting risk records in my models. That tells me that when we do get a correction lower, it is likely to be very large and steep for we are at stock market levels that have not been historically sustainable, particularly in an economic growth environment that is modest at best. Coupling this extended market condition with the momentum indicators above simply makes me more and more cautious.

As always, be careful out there and have a great week.


Deja Vu

Tom Connolly’s Equity Market Forecast
for the upcoming week beginning Aug 15, 2016
With Market Questions and Answers

Summary Comments:

I keep a personal diary that captures my feelings about the market. While I write in it often, it is not an everyday event. The other day, as I look back, the words I wrote seem to be the right words for the Summary comments in this weeks’ blog post. So, without further comment, this is what I wrote on August 10, 2016:

“My thoughts and feelings are very mixed. The losses I have incurred from my short positions are large. Fortunately, the gains from my precious metal positions have exceeded the losses on the shorts, providing an overall 11% YTD gain. I am tormenting myself over keeping the short positions. By every measure I track and look to over time to determine points of extreme excess or opportunity, today we are as exposed as ever at a point of irrational heights. Yet the market dynamics of high/lows, of advancing volume and advancing issues all confirm the move higher. A conundrum.

Do I keep the shorts in place after suffering such extreme losses?

Do I liquidate the precious metals after enjoying such extreme gains?

Why have valuation fundamentals become so disregarded by the market?

I am struggling to choose a path.

Best case scenario for my portfolio would be:
1) A serious market correction
2) A continued rise in precious metals

Worst case scenario for my portfolio would be:
1) A continued rise in equity indexes
2) A large decline in precious metals

What do I believe are the odds of each scenario happening?
1) Best Case:
a. Market correction in the current environment 25%
b. Gold and Silver going higher 65%

2) Worst case:
a. Market continues to rise 35%
b. Gold and Silver drop meaningfully 20%

3) Fill to get to 100%:
a. Market is flat 40%
b. Gold and Silver consolidate 15%

Given this perspective, I am going to hold my positions.”

As always, be careful out there.

Prior week’s investing activity: Last week was very much steady as she goes. I trimmed a small amount of the Gold mining position to take some profits off the table, added a little to the S&P September put option holding, and otherwise was very inactive.

My portfolio’s YTD performance vs the market, and its current composition as of Aug 12, 2016, are as follows:

Connolly Portfolio YTD gain as of Aug 12, 2016 equals +10.20%
S&P 500 Index YTD gain as of Aug 12, 2016 equals + 6.85%
NASDAQ Index YTD gain as of Aug 12, 2016 equals + 4.50%

The Portfolio’s composition as of Aug 12, 2016 is as follows:
• Cash 51.7%
• Equities 28.3%
• Gold 18.0%
• Fixed Income 2.0%

Forecast for the coming week: This coming week is the anniversary of last summer’s dramatic decline. The market metrics of July 2015 and July 2016 are twins, and not that last year should guide this year, but the level of overvaluation today is even greater than last year. Best to be careful. For the upcoming week I do not see any driving news or events that will change course. Presently, we have been in a rising market that lacks drama, so my view is to be careful and to not be complacent as this walking on a tight-rope is not for the weak of heart. Being ready to act is paramount as the current market move higher is approaching a length in time that often reflects fatigue and a need to rebalance through a correction.

Market Questions and Answers

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?

New index highs dominated the headlines last week (S&P 500, NASDAQ and DJIA), a triple that last happened in the year 1999. The DJU and the DJT did not attend the party and should be kept in our peripheral vision as a cause of potential concern. The trend in overall equities remains higher, but not in a rational way.

Relative Strength: We are in overbought territory on the RS indicators. The DJIA reading is 72, the NASDAQ reading is 75, and the S&P reading is 74. The NASDAQ has moved higher for seven straight weeks. The continued advance has stretched valuations like a rubber band, and any continued move higher will only serve to add tension and power to a potential snap-back event in an overbought and over-valued market.

Price Earnings multiples are 25.27X for the S&P 500 and 20.24X for the DJIA, indicating an expensive market to invest in at these levels.

The DJT remains in a declining chart pattern. It was modestly down this past week while the broader equity indexes rose. It has been a leading indicator of the broader market these past two years and should be watched closely for confirmation of a move higher or indications of a reversal in economic fortune.

The DJU has been churning over the past four weeks around a new high as investors seek yield reflecting the cautionary investing strategy of a market that poses greater risk then reward for investing in growth oriented businesses.

What is the current score on the “Market Tells metric”?


The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 214. As an FYI, when we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal. The -214 is the highest negative reading I have ever seen. Some of the components are at levels that are scary in regard to over-valuation.

The Portfolio’s Cash flow multiple based on expected 2016 full year results is 20.06X. This reading of price to cash flow is the highest reading over the past ten years. If we were experiencing continued rises in growth of future cash flow estimates and rates of growth in cash flow generation then one could justify the high current multiples. However, we just reached the lowest level of cash flow growth projections for the year, now at only a 0.61% growth YoY (August 2016 vs August 2015), and for the full year 2016 vs 2015 the growth is projected at only 1.58%. At some point in time this rising price environment in a declining cash flow growth environment will break.

Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 84 companies were priced above their DCF value. This is a new record high of the percentage of the portfolio that is trading above their discounted cash flow values. The 187 company portfolio’s historic average of prices above DCF is 61. This warns of an expected fall in the market as more companies are overvalued and will need to correct lower to create a more attractive risk reward profile.

The dollar spread between the Current Price and the Discounted Cash Flow price utilizing 2017 cash flow projections on the 187 Portfolio Companies is now at $12.29. This is based on a projected cash flow increase in 2017 over 2016 of 13.09%. The difference or spread today between the current price and the DCF price is the lowest in my tracking history and is meaningfully below the historic median of $22.13. A higher spread indicates greater value to invest in whereas a lower spread indicates subpar returns will be realized from investing at current prices. In this environment it should be apparent that future performance has been pulled into the current pricing in a manner that reduces potential gains absent a significant improvement in future earnings and cash flows.

What is the position of the weekly net up down Vol/Issues?

The week’s volume and issues have faded in terms of validating the index point moves higher. Of particular note is that the weekly average volume totals are falling to levels unsupportive of the level needed to confirm the strength of the index point moves higher. Declining volume in a rising market is troublesome. This is after taking into account the seasonal phenomena of the summer in the city doldrums and the migration to the beach.

What are the daily point vs issues and point vs volume measures indicating up or down?

The daily trend is supportive but in a lessening manner. The daily metrics of (1) index point moves being supported by the daily advancing or declining volume, and (2) the index point moves being supported by the daily rising and falling number of issues, confirmed the support for the market.

Where are the New Highs and Lows moving toward?

The momentum in new highs vs new lows appears to be tiring. We are seeing a static number of new lows, and a declining level in new highs (note daily new highs are happily in excess of new lows, so there is confirmation of the underlying participation of the broader market in the rally higher, but the gap is shrinking over the past two weeks and warrants paying attention to in regard to whether the participation is beginning to narrow).

How well are Market Tells correlating with Market trading internals?

The technical market indicators and the Market Tells of valuation are not in alignment. This is an indication that future volatility will arise to bring about a resolution of this imbalance. As we continue to extend gains the level of risk for a dramatic decline to adjust the price of the market to the cash returns from the market becomes increasingly dangerous. Close attention needs to be paid to exogenous events that could ignite a market reversal.

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation Index (“CEDATEV”)?

The reading is minus 2 (-2). This score reveals a market that has many competing influences. The world events and economic trends coupled with an expensively priced group of stocks and bonds pose significant risk, but the emotion does not show a reversal to the downside.

Contributors are:

Negative in the following areas:

Positive in the following areas:

Neutral in the following areas:


Bitcoin weathered a storm brought about by the hacking of a Hong Kong based exchange and the theft of millions of dollars of Bitcoin. The price per BTC fell to the mid-low $500s before moving to its current level of $573. The per unit value based in the low $400 area over the past four months. Over the past year, the price has increased by over 200% from the $230 area. I hold a position in Bitcoin as we move closer to digital currencies.

The Dollar Index has been consolidating in the 95 to 96 area. Over the past twelve months it has traded between 93 and 100. The dollar has appeared to be range-bound in this area. A continued strengthening could pose issues for the Emerging markets.

Gold closed the week at the $1,341 per ounce. The global phenomena of negative interest rates on sovereign debt in many parts of the world are giving support to the price of Gold. Over the past month, the Gold and Silver Miner equities have risen materially. Results for the quarter ended June 30 were very good, and the action in the $1,300 per ounce area does not show signs of any meaningful pullback. I believe there is much more room to the upside for these equity holdings. Given the continued global uncertainty and currency volatility issues that exist, I do see material price increases for gold and silver in the foreseeable future and for Gold to advance much higher above the $1,300 level. I will therefore maintain my PM positions (with modest sized exits and entrances to capture periodic swings above or below a normalized trend) to offset potential equity price declines from the broader market.

The Ten-year bond yield weakened a bit this week and closed at 1.51%. The economic signals I see from the latest government releases show an economy that continues to operate in a very modest way, often presenting signs of continued slowing. The behavior of the Bond market is confirming that economic slowness. Of concern is a flattening of the yield curve (recession) with only slightly more than a 1% spread between 3-month money and 10-year money.

Commodities: This week we saw the CRB commodities index stabilize. The softness in economic demand factors, the supplies on the market and the stability in the value of the U.S. Dollar are neutral to negative for the pricing of Oil and the Industrial commodities. Deflation remains a concern.

The High Yield vs Investment Grade spread contracted to give further support to the no-fear environment and the aggressive pursuit of risk for yield. We closed this week at a spread of 3.484% and the indication was to take risk-on. High Yield is at 6.124% and Investment Grade is at 2.64%. If the oil market fails to hold the price of a barrel near the $45 to $50 mark or higher (right now we are rallying to the $45 per barrel mark), the health of the high yield market may once again show pressure. A fall in oil will be problematic for the High Yield market and a general negative for the overall market. However, right now the HY arena is backing a continued commitment of money to the market.

That about covers it.

As always, have a great week!


Equity Portfolio Activity for the Week ended August 12, 2016

Equity Portfolio as of August 12, 2016

Commentary: The large gains in the Gold and Silver mining equities have marginally exceeded the losses of the short hedges. I have debated reducing the short hedges but given the fact that by every measure I track and analyze, today’s market is priced at a level that offers limited gains from continued price increases. The market is at a level of extremes that pose great downside risk. Of course, emotionally motivated buying can continue to feed the rise in prices, but for this investor it is best to watch from the sidelines and to maintain hedges that will offset the impact of equity price declines. During the week, I modestly increased the short hedges.

Good Luck and have a great week!

New Additions

1. None

Increase in Holdings

1. First Solar
2. S&P September Put Options

Complete Dispositions

1. Alamo Gold

Partial Decrease in Holdings

1. Ultra Short VIX

Overall Equity Portfolio holdings

1. Alamos Gold – Closed position
2. ASA
3. Arm Holdings
4. BB&T Corp
5. Brocade
6. Brookfield Total Return
7. Chevron
8. Con Ed
10. Disney
11. Eastman Chemical
12. Endo Int’l
13. First Solar – Increased position
14. Ford
15. General Electric
16. Golar LNG
17. Halliburton
18. Harmony Gold Mining
19. Hecla Mining
20. Hershey
21. Ingredion
22. JP Morgan
23. Microsoft
24. New Gold
25. Nordic American Tanker
26. Norfolk Southern
27. Phillips 66
28. Pro Shares Ultra Short S&P 500
29. Pro Shares Ultra VIX Short – Decreased position
30. Qualcomm
31. S&P E-mini short futures
32. S&P 500 September Put Options – Increased position
33. Synaptics
34. Tetra Technologies
35. Travelers
36. Twitter
37. Viacom
38. Wells Fargo
39. Yum! Brands